Burned Out and Turning Out

When the budget targets were released in March showing education to be a big winner in this year’s competition for general fund support, the press release from Education Minnesota seemed remarkably subdued, even a bit alarmist.  “There are parts of this budget agreement that could change the lives of students and educators and that’s worth celebrating, but it would also leave thousands of veteran educators behind. The proposed investment in pension reform is extremely disappointing.  We need to fix educator pensions to retain great educators who have no hope of a reasonable retirement in the current teacher pension system.”

The quote indicates that in the eyes of Education Minnesota and many of its members, more money is needed in order to leave the classroom as well as enter it.   Lawmakers have been inundated with letters, emails, and calls describing how the realities of the modern-day classroom -- increased workloads, administrative demands, lack of autonomy, and student mental health challenges -- to name just a few issues – are taking a toll on teachers. 

The “fix” is lowering the retirement age at which teachers could receive their full pensions without a reduction for getting the pension early.  The pension system itself (TRA) sought to allow retirements with full benefits if members were at least 60 years old and had at least 30 years of service.  Education Minnesota proposed a variation on the same theme: full benefits at 62 years or 35 years of service.  (Each proposal also included COLA adjustment provisions, and in the case of Education Minnesota a couple of other provisions adding to the cost.)   The TRA’s early retirement provision, the only one with an actuarial cost estimate accompanying it, was projected to cost about $204 million in the first-year compounding at 3% every year thereafter.  However, only $600 million in one-time money out of $3.3 billion requested by the Commission Chair for pensions was included in the global budget targets.  That sum is simply inadequate to deliver on the proposal, especially since these resources were also needed to address issues in other state pension systems.  

From all indications, this is an issue that is not going away.  We look at the history behind the issue, the comparisons being made with other state teacher funds, and what might be done.

A Situation Developing Over Three Decades

The frustration and irritation communicated to lawmakers today has its roots in decisions made a generation ago.  In 1989 Minnesota lawmakers wanted to increase retiree benefits for public employees but were split on how to do it.  Some wanted higher pension formula multipliers (a.k.a. accrual rates); some wanted a better early retirement feature than currently existed at the time.¹  The Solomon-like decision was to do a little bit of both resulting in the “two tier” system that exists today.   Anyone hired before July 1, 1989 would be part of the “Rule of 90” allowing retirement with full benefits if the sum of an individual’s age and years of service equaled 90 or more.  Anyone hired after this date (“Tier 2”) received a higher formula multiplier for their first ten years of service than their Rule of 90 counterparts.  However, pension benefits would be reduced if these individuals retired before the “normal retirement age” of 65 (now 66).   This change applied, and continues to apply today, to the state’s MSRS and PERA systems as well, not just TRA.

Even though the formula multiplier provided to Tier 2 teachers for their first 10 years of service was higher, the waiver of the early retirement benefit was more valuable effectively creating a subsidized benefit for pre-1989 employees.  As the years have progressed, the inequities between the pre- and post-1989 cohorts have been compounded by Minnesota’s long history of taking a rather “relaxed” approach to making its actuarially required contributions in a timely manner -- all exacerbated by improper liability discounting practices which kept contribution rates lower than they should have been for the promises being made.  As a result, TRA now faces about $8 billion of unfunded liabilities with less than 20 cents of every dollar of employer pension contributions available to pay for the benefits of active teachers, most of whom are now Tier 2.  The rest is required to pay off pension debt.²

Over the years periodic interest in restoring the Rule of 90 has been met with general resistance by lawmakers.   The reasons still have relevance today.   It costs a lot.  It creates coordination conflicts with federal retirement policy like Medicare eligibility.  Retiring baby boomers mean labor markets are tight, and keeping people in the workforce rather than incentivizing them to retire is a good idea.  One thing has changed.  For a long time, early retirement was not an issue asking for prompt attention since those who started in the public workforce after 1989 were in early-to-midcareer situations creating little demand for the provision even if it existed.  As lawmakers can tell you, those days are over.

Benchmarking Minnesota Teacher Retirement Treatment

There is no question Minnesota is an outlier both with respect to its normal retirement age for teachers of 66 (highest in the nation) and having no provisions for earlier retirements with full benefits.  Comparative examples of early retirement treatment between Minnesota and other states can generate some stark differences in final pensions for the same combination of age and years of service.

However, early retirement provisions are just one of many defined benefit plan design features, all having cost considerations and entailing potential trade-offs.  These other features are no less a factor in the “competitiveness” of a retirement plan.  A look at our neighboring states, which have been frequently highlighted as case examples, illustrates this point:  

• Wisconsin teachers can retire with a full pension at 57 with at least 30 years of service.   However, their formula multiplier is 1.6% (vs. 1.9% in Minnesota) which means the system is designed to replace about 10% - 15% less wage income.   

• Iowa teachers can retire under a “Rule of 88.”   Their formula multiplier is also slightly higher at 2%.  But they do not provide a cost-of-living adjustment (COLA), ever.  As their pension system says, “IPERS isn’t intended to be your sole source of retirement income. We encourage our members to save for retirement.”

• South Dakota has a full benefits retirement age of 65, one year earlier than Minnesota.  Their employee contributions are lower, but so is their formula multiplier (1.55%).

• North Dakota teachers can retire under a “Rule of 90” but teachers pay 4 percentage points more of their salary than in Minnesota.  There are also no provisions for annual COLA adjustments.

The influential “final average salary” on which the benefit is based can also vary considerably from state to state influencing benefits.We cannot find any state comparative statistics on this, which is understandable since that is a function of both individual decision-making and variations within a state based on different district total compensation designs and levels.For some highly imperfect perspective, according to the National Center for Education Statistics, in 2023 the average teacher salary is 0.2% to 19.3% higher in Minnesota compared to the states it borders.

Benchmarking also reveals interesting findings regarding equity among teachers within pension systems. The idea of uniform treatment of all teachers within a system is compelling, but different treatment of active teachers within state pension systems is ubiquitous and the norm, rather than the exception, across the country.   According to the Urban Institute, since 2008, thirty-seven states that offer final average salary defined benefit pensions to teachers have changed the terms of those retirement plans so that benefits rules for teachers hired on or after January 1, 2018, differ from those for teachers hired 10 years earlier:³

• 20 states increased the age in which a teacher could retire with full benefits
• 25 states increased mandatory teacher contribution rates
• 13 states reduced the share of salary the pension replaces
• 15 states increased the number of years included in final average salary computations
• 12 states increased vesting retirements
• 6 (now 7) states have moved new teachers completely out of defined benefit plans

Others have created retirement plan options for new teachers such as hybrid or cash balance plans.   

These findings indicate that despite the diversity of plan designs, most teacher defined benefit plans share a common bond: grappling with the demographic and economic realities of maturing plans, the frequently faulty economic premises on which they have been constructed and governed, and the resulting large unfunded pension obligations.  At least 18 state teacher plans need to devote even more than Minnesota’s 80 cents of every dollar of employer contributions towards pension debt payments – most, if not all, of which have early retirement options.   In this context, any benefit improvement is difficult to implement, and policy adjustments are often required in the other direction.

Lessons From a Surprising Source

Is it possible to combine a high-quality defined benefit plan with an early retirement provision and do it without creating significant risk to plan health?   The answer is yes, and teachers do not have to look far to find an example since they are paying for such a defined benefit plan as well as their own plan.  It’s the defined benefit plan for the employees of their own union, Education Minnesota.

As a private, single-employer defined benefit plan, the Education Minnesota Employees Pension Plan files actuarial information annually with the Internal Revenue Service.  According to its latest filing the plan serves 380 current and former employees.  Like most private defined benefit plans, 100% of the contributions come from the employer which means 100% of the contributions come from TRA membership dues.

It is considerably healthier than the TRA plan with a funded ratio (plan net assets/plan liabilities) of 101.2% compared to a TRA funded ratio of 81% (prior to the lowering of the liability discount rate to 7%).   The Education Minnesota employees plan also substantially exceeds the TRA plan on both eligibility features and generosity dimensions:

• The monthly accrued benefit (formula multiplier) is 2.0% vs 1.9% for TRA. 
• The final average compensation is based on highest 3 earning years versus highest 5 for TRA members
• Special retirement benefits – sums paid in addition to any other benefits earned under the plan -- are provided to executive staff, associate executive staff and Education Minnesota officers.
• The Education Minnesota defied benefit plan has no COLA.   However, the organization also offers a tax deferred contribution plan with a generous 7% employer match (also from member dues).   

As for early retirement, Education Minnesota employees can retire with full benefits at age 55 with 5 years of vesting.   

What explains the large difference in both health and generosity of these two plans?    Part of the answer is attributable to old fashioned federal regulation.   In 2006 Congress passed the Pension Protection Act -- regarded as the most comprehensive reform of the nation’s pension laws since enactment of the Employee Retirement Income Security Act (ERISA) in 1974.  

It established new funding requirements for private sector defined benefit plans.  It obligated pension plans to calculate the present value of their liabilities based on bond rates that reflected the length of time until when those liabilities would need to be paid.  It reduced allowable amortization periods for unfunded liabilities.  It established a new “at risk” category for defined benefit plans whose sponsors are required to make larger contributions to offset the greater liability of these plans.  (The federal “at risk” threshold is 80% funded – which paradoxically is the same funding threshold many advocates have used to label public sector pension plans as “healthy.”)   

In short, it demanded rigorous and responsible funding practices.   Education Minnesota and other private plans must operate under these requirements.  In contrast, public plans operate under laws states enact that too often reflect budget conditions and political feasibility.

But the biggest influence is the law of concentrated benefits and dispersed costs.   The cost of the defined benefits plan serving 380 Education Minnesota employees and retirees is supported by over 80,000 TRA active members.  Our back of the envelope calculation suggests about $37 of annual member dues goes to fund Education Minnesota’s employee retirement offerings.  Even though the ratio of TRA members to state taxpayers seems similarly favorable, the law doesn’t work the same way given the intense competition for state government resources.  Which is why Pension Chair Her’s introductory budget remarks that included an ask of frustrated observers for continued input on what actions to pursue came with this caveat.  “Don’t come to me and tell me you don’t like what I did,” she said.  “Come to me and tell me who do you want me to take money from so that I could give it to you.”

An End of Session Surprise?

We will soon find out if those words were taken to heart, and if so, who/what the sacrificial lambs are.   With just three weeks left in the session, the Pension Commission has added a meeting to hold an informational hearing on HF3294 introduced on May 1 and appears to be Education Minnesota’s “Plan B” proposal for Tier 2 teachers.  For plans coordinated with Social Security it would:

• Reduce the normal retirement age to 64
• Increase employee contributions (after June 30 of this year by an additional 0.5% (above an already scheduled increase of 0.25%) to 8.25%
• Increase employer contributions (for plans coordinated with Social Security) after June 30 of this year by an additional 1.0% (above an already scheduled increase of 0.2%) to 9.75%
• Create a fresh 30-year amortization period for unfunded liabilities (2053).
• Provide some to be determined additional amount of general education aid to help cover the cost.

Our rough estimate of additional general education aid to cover the additional employer cost of this proposal is $60 million per year.   Advocates are almost certainly buttonholing both Education Finance committee chairs to squeeze that money out of their existing bills.   Since neither the House or the Senate Education Finance Committees have heard this bill, we presume it will require some type of rules suspension, floor amendments, or other process maneuvers to get this enacted.

The fate of early retirement may still be in limbo but we do know the claims of teachers having “no hope of having a reasonable retirement” is hyperbole of the worst kind.  The TRA pension plan in coordination with Social Security is constructed to replace about 85% of a career teacher’s average five highest earning years for life and is backed by Minnesota taxpayers.   If that seems “unreasonable,” it may be because the union is comparing TRA against the defined benefit plan it offers its own employees.  Education Minnesota may want to consider a goodwill gesture of cutting back on those special executive retirement bonuses or even a small, albeit symbolic, dues cut to demonstrate some recognition of its dues-paying members’ contributing to their own defined benefit plan while paying for another.

In solidarity, of course.

Footnotes

¹ A rule of “62 and 30” was established for statewide plans in 1973. In 1982 a “rule of 90” was created for the PERA General Plan.  Action in 1989 extended the rule of 90 to all state plans at the same time the current two tier system was created.

² Pension Contributions by State 2022, Equable, November 10, 2022. Calculations based on actuarially determined contribution requirements. Actual state contribution policy may differ.

³ How Have Teacher Pensions Changed Since the Great Recession?  Urban Institute, February 2020